Wealth Planning Challenges Corporate Executives Face
As you climb the corporate ladder, the financial rewards can be lucrative. It can also present some unique challenges for your overall wealth plan. What is the best payout election for your Non-Qualified Deferred Comp plan? How much money are you leaving on the table with unvested stock options if you take the new job offer? How much will you have to pay in taxes when your Long-term incentive reward pays out next year? These are just a few of the many questions corporate executives must answer when planning for their future. A limited knowledge of your company’s retirement plan, benefits package, performance awards and long-term incentive programs could cost you thousands of dollars in lost income as well as taxes. In an effort to avoid those mistakes, let’s review some of the most common wealth planning challenges corporate executives face.
Determining Your Deferral into Your Company 401k Plan
Have you ever deferred a portion of your salary to your company’s 401k plan only to receive a letter in the mail accompanied with a check the following year that informs you that you can’t defer that much into the plan? Provided you were under the IRS deferral limits, chances are your company’s retirement plan failed it’s year-end testing. Asking your HR professional if highly compensated employees can max out their contributions into the retirement plan isn’t often high on the list of questions during an interview with a new company. It should be. The IRS sets the annual deferral limits along with the catch-up provisions. However, your plan also must pass various testing (I’ll spare you the reasons) at the end of the year. Depending on your company’s plan design, highly compensated employees may not be able to max out the IRS limits. If you have planned to use your 401k plan to save for retirement and fail to ask the right questions of your employer, you may find yourself having to find new vehicles for saving.
Understanding the Roth 401k
Many companies are now offering a Pre-tax and a Roth 401k option. One of the most common misconceptions I hear is, “I can’t contribute to the Roth 401k because I make too much money.” The confusion here centers around the difference between a Roth IRA and a Roth 401k. The Roth IRA absolutely has a contribution limit that is determined by your Adjusted Gross Income (AGI). As a high earner, it is probable that you earn too much to directly contribute to a Roth IRA. However, the beauty of the Roth 401k is that it is not subject to the same income limits. No matter what your income is, if your company offers a Roth 401k option you are allowed to participate (provided you meet your plan’s other eligibility requirements). The benefit of contributing to a Roth 401k is that while you must pay taxes on the income now, provided you follow the distribution rules, you won’t pay taxes if you withdraw from it during retirement. This means you never paid taxes on the earnings which is why it can be a significant wealth building tool. Determining how much to defer to a Pre-Tax 401k vs. a Roth 401k option is another decision point you must consider, but you should at least be aware that you can contribute to the Roth 401k.
Realizing the Risks of a NQDC Plan
Your employer may offer a Non-Qualified Deferred Compensation plan (NQDC) to its highly compensated employees. It’s considered a benefit for corporate executives because it allows you to defer a larger portion of your compensation. Another benefit is that you can schedule distributions throughout your career – not just during retirement. A NQDC plan differs drastically from a 401k plan, and it’s important to understand the differences. A 401k plan is considered a qualified plan. As a qualified plan, it must abide by the Employee Retirement Income Security Act (ERISA). ERISA provides a level of protection that is not afforded to a non-qualified plan. The NQDC plan is merely an agreement between an employer and employee. There is substantial risk which includes losing your assets in the NQDC plan, especially if down the line your employer files for bankruptcy. When you are early in your career, trying to predict your company’s future in 30 years is challenging. Knowing how to weigh the risk, plan your deferrals and your distributions can be intimidating even to the most seasoned executive. It’s critical to understand how much risk you can tolerate within your financial plan. Participation in the plan should also warrant a tax planning conversation as you determine your elections.
Evaluating the Alphabet Soup of Corporate Executive Compensation
Acronyms. Get to know them well. As it relates to the wealth planning challenges corporate executives face, understanding your financial acronyms may be the most important to your financial success. ESPP, RSU, PSU, and LTIP are just a few that will impact your planning. Equity performance rewards and long-term incentives often come in the form of company stock and have a stated vesting period. The vesting period determines the timing of the payout. Let’s look at an example of how this impacts wealth planning. Consider if you were offered an $80,000 LTIP (Long-term Incentive Plan) that will pay out in RSUs (Restricted Stock Units), but it has a 48 month vesting period and an additional six month waiting period before you can sell them. This means you would be able to potentially realize that money in four and a half years. Will your company withhold a certain amount of your shares to cover your tax bill when the shares vest? Will you decide to sell all the shares in four and a half years to receive the $80,000, or will you strategically consider a plan to diversify? These are just a few of the questions you will need to consider in your wealth planning. We’ll take a look later at what happens to these financial rewards if you decide to leave the company.
Thinking Long-Term for Your HSA
Speaking of acronyms, let’s talk about another one – the HSA. A Health Savings Account, commonly referred to as an HSA, is a savings account that allows you to defer a portion of your salary on a pre-tax basis to save for qualified medical expenses. Unlike the FSA (Flexible Spending Account), the funds in an HSA rollover from year to year. With a maximum contribution limit of $7,000 annually for a family (if you are younger than 55), this small but mighty planning tool is often overlooked in the wealth planning for corporate executives. The common objection for corporate executives not contributing the max to an HSA is that you don’t have many medical expenses and wouldn’t use it. This is exactly why you should consider it! If you think beyond the now and the current use for an HSA, it has the potential to be the triple threat of retirement planning. You won’t pay taxes on the money contributed. Provided that you use the funds to pay for medical expenses at some point, you won’t pay taxes on the earnings or when you make the withdrawal. Rising health care costs could create a significant expense for corporate executives that want to retire before age 65 and Medicare. When thoughtfully used, an HSA could be a solution to this problem. HSA funds can also be used to pay for long-term care insurance premiums as well as Medicare premiums. Think twice before you overlook the HSA during open enrollment.
Unwinding a Concentrated Wealth Position
The definition of a concentrated wealth position can vary. For our purposes, we will define it as any position that is more than 10% of your overall investment planning portfolio. As we examined earlier, company stock options can be lucrative. They can also create more risk. The longer you work for a company your chances for a concentrated wealth position increase. You are likely awarded new performance rewards and incentives in the form of stock options each year which begin to layer on top of each other. As the rewards vest, you’re faced with the decision of selling, donating or holding the position. If you are feeling bullish about your company’s future, it’s tempting to hold the position so that you can leverage the future growth. What happens though if the future wasn’t as bright as you thought it might be? If you think it would never happen to your company, consider the following names: Texaco, General Motors and Enron. A pandemic in 2020 also accelerated the bankruptcies of JC Penney, Neiman Marcus, J. Crew, Guitar Center, and Pier One. Could you afford to lose all the wealth associated with your company stock and still live the life you want to live? If not, it’s time to consider diversification. Even if your company never faces bankruptcy, you will still need to understand tax implications of holding or selling your company stock. Planning wisely could save you thousands of dollars in taxes.
Breaking the Golden Handcuffs
Incentives and performance awards are referred to as golden handcuffs for a reason – they are designed to deter you from leaving your current company. Companies spend a great deal of money to recruit, hire and train employees. Yet, corporate executives are talented individuals and highly sought offer employees so there is a high probability you will have to consider breaking the golden handcuffs during your career. That presents the challenge of understanding what money you would be leaving on the table should you leave your current company. Non-vested awards and incentives are forfeited when you leave, which equates to loss of wealth. If you were participating in a NQDC plan, any vested money you have in the plan could be distributed to you immediately depending on the terms of your agreement. Realizing the income that you had intended to defer for a later period may create a sizeable taxable event. Negotiating an employment offer with a new company will require you to understand what you are leaving behind. Do not be afraid to ask for a reasonable equity buy out. Evaluate the terms and vesting period of the new awards the job offer includes. Compare the timing of the wealth pay outs you are leaving behind to the new terms of the wealth you are being offered. Consider the culture of both companies. More money does not always equate to more happiness or job satisfaction.
Finding the Right Partners
Often, the best strategy for managing your executive compensation rewards is to not try and tackle it alone. You are a leader for a reason. You know how to identify talent in others, delegate work and ultimately manage the team to produce the overall results you desire to achieve. Identifying and working with a good team of professionals, including a CPA, a Wealth Advisor, and an Estate Attorney, to manage your wealth should be no different. A proactive team will seek to educate you, involve you as needed, guide you where appropriate and ultimately allow you to spend more time doing what you do best. It leaves you free to do the things you love and to dream about the life you want to lead in the future.
Article by: Jennifer Fensley, CFP®️,CRPS®️
If you would like to learn more about CapSouth Wealth Management please visit our website at www.CapSouthWM.com If you would like to have a conversation to discuss this article further, I’d love to chat. 334.673.8600. capsouthwm.com/services/financial-estate-planning/
CapSouth Partners, Inc., dba CapSouth Wealth Management, is an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. This material has been prepared for planning purposes only and is not intended as specific advice. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences.
